MWP 2016/18 Max Weber Programme Economic Diplomacy in Africa: The Impact of Regional Integration versus Bilateral Diplomacy on Bilateral Trade Author Sylvanus Author Kwaku and Afesorgbor Author Author European University Institute Max Weber Programme Economic Diplomacy in Africa: The Impact of Regional Integration versus Bilateral Diplomacy on Bilateral Trade Sylvanus Kwaku Afesorgbor EUI Working Paper MWP 2016/18 This text may be downloaded for personal research purposes only. Any additional reproduction for other purposes, whether in hard copy or electronically, requires the consent of the author(s), editor(s). If cited or quoted, reference should be made to the full name of the author(s), editor(s), the title, the working paper or other series, the year, and the publisher. ISSN 1830-7728 © Sylvanus Kwaku Afesorgbor, 2016 Printed in Italy European University Institute Badia Fiesolana I – 50014 San Domenico di Fiesole (FI) Italy www.eui.eu cadmus.eui.eu Abstract The paper examines the impact of two main instruments of economic diplomacy regional integration and commercial diplomacy on export flows among African states. We test whether there is any evidence of a trade-off or complementary interaction between these two instruments in trade facilitation. We compare the effects of these two instruments of economic diplomacy on bilateral trade by employing a gravity model for 45 African states over the period 1980-2005. The results show that bilateral diplomatic exchange is a relatively more significant determinant of bilateral exports among African states compared to regional integration. We also find a nuanced interaction between these two instruments of economic diplomacy: the trade-stimulating effect of diplomatic exchange is less pronounced among African countries that shared membership of the same regional bloc. Generally, this could mean that there exists a trade-off between regional integration and commercial diplomacy in facilitating exports or a lack of complementarity between these two instruments of economic diplomacy. Keywords Economic Diplomacy, Regional Integration, Bilateral Diplomacy, African Trade. JEL Codes: F51, F14, O55 We thank an anonymous referee, as well as the editors of the book Peter van Bergeijk and Selwyn Moon, for their valuable comments. Sylvanus Kwaku Afesorgbor Max Weber Fellow, 2015-2016 Robert Schuman Centre for Advanced Studies, 2015-2016 European University Institute, Florence, Italy; email: [email protected] . Department of Economics and Business Economics, Aarhus University, Aarhus V, Denmark; e-mail: [email protected]. 1 Introduction More recently, the influence of politics on international trade has gained acceptance in economics. Many studies have emphasized the relevance of political or diplomatic relations in facilitating trade. They argue that diplomatic relationships between states taking the forms of state visits, opening trade missions, consulates and embassies are significant determinants of bilateral trade between countries (see, for example, Rose 2007; Nitch, 2007; Yakop and van Bergeijk, 2011; Moons and van Bergeijk, 2016). Conversely, strained political relationships between states can also deteriorate trade flow between them (see, for example, Fuchs and Klann, 2013). Afman and Maurel (2010) identify facilitating exports as one of the explicit objectives of foreign diplomatic missions. This has been one of the main justifying economic rationales for establishing diplomatic missions abroad. Especially, the export-promoting functions of national companies to their host countries. There are many countries, both developed and developing countries that spend huge sum of their national budgets financing the activities of diplomatic missions abroad. However, for developing countries, the costs of financing these diplomatic activities constitute a substantial proportion of their national budgets. This may result in them only establishing diplomatic missions in few countries, or diplomatic missions will be allocated meagre financial resources that may not allow for any intense activities geared towards promoting bilateral trade. Comparing the impact of the diplomatic representations of developed and developing countries, Yakop and van Bergeijk (2011) show that diplomatic representations are even more relevant for developing countries as they contribute more significantly in enhancing South-South trade than North-North trade. In a meta-analysis study, Moons and van Bergeijk (2016) find that the impact of diplomatic exchange is conditional on the level of development of the trading partners. 2 For example, they state that the effect of diplomatic exchange is more significant for South-South, North-South and South-North trade compared to North-North trade. Moons and van Bergeijk’s (2016) finding may be theoretically plausible since possible market and coordination failures resulting from information asymmetry may be more severe for developing countries compared to developed countries. However, their claim about the importance of diplomatic representations for South-South trade has not been put to an empirical test in a large cross-country analysis for developing countries, especially for Africa. This is important because previous studies that have analyzed the trade facilitation roles of diplomatic exchange focus exclusively on trade between North-South, South-North and North-North partners. For example, Afman and Maurel (2010) limit their sample to cover only OECD countries, Head and Ries (2010) only focus on Canada as an exporter; and similarly, Rose (2007) restricts its sample to only cover exports from advanced countries. This study focuses specifically on South-South trade by comparing the impacts of diplomatic representations1 and regional integration on African trade. More importantly, it examines whether there exists any interaction between these two instruments of economic diplomacy in the case of African countries. Africa offers an interesting perspective for comparison of these two instruments as the region is noted for its extreme level of overlapping and multi-membership of regional economic integration schemes (see for example, Yang and Gupta, 2005 and Afesorgbor and van Bergeijk, 2014). This comparison is particularly interesting as regional integration is argued to constrain the policy space of the member states of the regional blocs and thus, leave less space for bilateral negotiations (see for example, Woolcock, 2011 and van Bergeijk, 2011). Woolcock (2011) argues that greater regional integration would mean less scope for national commercial diplomacy by the member states. Put similarly, van Bergeijk (2011) confirms this by stating that increasing 1 We use the terms diplomatic representation, diplomatic exchange and bilateral diplomacy interchangeably. 3 regional integration activities would leave less space for countries to embark on rigorous bilateral diplomatic activities to promote trade and investment. Diplomatic relationships are relevant in minimizing potential risks that businesses encounter in their foreign operations. Various forms of risks such as political, legal and credit risks may discourage potential exporters from entering foreign markets. However, these risks may be minimized if there are established diplomatic or political ties between countries. This is mainly because, they will signal or give assurance to international firms that their governments are on good terms and thus, their interests will be respected. Exposure to these risks is more commonly associated with South-South trade. For instance, Anderson and Marcouiller (2002) attribute the high level of trade among high-income or capital-abundant countries to a high level of trust. They argue that high levels of mistrust and insecurity act as a hidden tax which increases the transaction cost of international trade, thereby impeding trade among developing countries. Theoretically, it is plausible to link the low level of trade among developing countries to these potential risks because the trade among developing countries is more characterized by high levels of mistrust and insecurity. Similarly, Moons and van Bergeijk (2016) justify economic diplomacy by developing countries mainly because of the existence of asymmetric information on doing business in low- income countries. They emphasize the scarcity of published statistics and information on business activities in developing countries. This therefore points to a relevance of foreign missions abroad, as they may be a better source of credible information for domestic firms seeking to enter the host countries of the foreign missions. There is also a strong argument that foreign missions are a necessary public sector investment as their involvement is a necessary condition for the reduction or elimination of cultural non-tariff barriers to trade and investment (Yakop and van Bergeijk, 2011). 4 Thus, this study focuses specifically on Africa for two reasons. First, diplomatic exchange among African states geared at promoting South-South trade has not yet been investigated at a sufficient level of detail. The focus on only African states is very important because apart from the insufficient number of studies that analyzed the effect of economic diplomacy on South-South trade; they also include a small number of African countries in their samples. For example, studies such as Yakop and van Bergeijk (2011) and van Veenstra et al. (2011) include less than 10 African countries in their samples. In addition, these studies used only